Charles Schwab Corporation — Q3 2019 Form 10-Q
Business context and reporting period. Schwab provides brokerage, banking, asset-management, custody, and advisory services through Investor Services and Advisor Services. This unaudited filing covers the quarter and nine months ended September 30, 2019; comparisons are with the same 2018 periods unless noted. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial and operating performance
| Metric | Q3 2019 | Change | First nine months 2019 | Change |
|---|---|---|---|---|
| Total net revenues | $2.711 billion | +5% | $8.115 billion | +9% |
| Net interest revenue | $1.631 billion | +7% | $4.921 billion | +17% |
| Asset management and administration fees | $825 million | +2% | $2.366 billion | -4% |
| Trading revenue | $172 million | -2% | $531 million | -5% |
| Expenses excluding interest | $1.475 billion | +8% | $4.379 billion | +7% |
| Net income | $951 million | +3% | $2.852 billion | +11% |
| Diluted EPS | $0.70 | +8% | $2.05 | +15% |
| Pre-tax profit margin | 45.6% | 47.3% prior year | 46.0% | 44.9% prior year |
- Net interest margin was 2.43% in both Q3 and the first nine months, versus 2.33% and 2.25%, respectively, in 2018. Management attributed the increase in net interest revenue mainly to higher investment yields and growth in interest-earning assets, partly offset by higher funding costs.
- Q3 expenses included $62 million in severance charges tied to a decision to eliminate positions covering about 3% of the workforce. Excluding interest, expenses as a share of average client assets were 0.16% annualized in Q3 versus 0.15% a year earlier.
- Q3 pre-tax income was $1.236 billion; the effective tax rate was 23.1%. Year-to-date pre-tax income was $3.736 billion and the effective tax rate was 23.7%.
- Operating cash flow was $5.021 billion for the first nine months. Investing cash flow was positive $13.259 billion and financing cash flow was negative $24.223 billion, including a $22.096 billion net reduction in bank deposits, $1.964 billion of share repurchases, and $808 million in dividends paid. Cash and cash equivalents, including restricted amounts, ended the period at $32.284 billion.
Balance sheet, capital, and liquidity
- At September 30, 2019, total assets were $278.987 billion, down from $296.482 billion at December 31, 2018; bank deposits were $209.327 billion, down from $231.423 billion. Management said client cash balances supported modest organic balance-sheet growth during Q3.
- Long-term debt was $7.427 billion, compared with $6.878 billion at year-end 2018. Schwab issued $600 million of 3.25% senior notes due 2029 in May 2019. No short-term borrowings were outstanding at quarter-end.
- CSC’s Tier 1 leverage ratio was 7.3%, and its supplementary leverage ratio was 7.1%. Schwab reported that CSC and Charles Schwab Bank met applicable capital requirements and were well capitalized.
- Average liquidity coverage ratio was 112% for Q3. Available external facilities included $35.2 billion of FHLB capacity, $750 million committed credit capacity, and $8.254 billion of Federal Reserve discount-window capacity; no amounts were outstanding at quarter-end. Facility availability is subject to collateral and other conditions.
- Client assets totaled $3.768 trillion, up 6% year over year. Q3 net new client assets were $56.6 billion; first-nine-month core net new assets were $145.5 billion, an annualized organic growth rate of 6%. Active brokerage accounts were 12.118 million, up 6% year over year.
Changes, outlook, and material developments
- Growth was led by net interest revenue. Fee revenue fell 4% year to date, primarily reflecting lower sweep money-market revenue after transfers to bank and broker-dealer sweep and lower Mutual Fund OneSource balances. Trading revenue declined as average revenue per revenue trade fell.
- Effective October 7, 2019, Schwab eliminated online commissions on U.S.- and Canadian-listed stocks and ETFs and the base charge on options. Using Q3 trading volumes, management estimated the reduction would have equaled approximately $90–100 million of Q3 trading revenue, or 3–4% of total net revenue. Management expects the pricing change to support the value proposition and long-term client and asset growth; the filing does not quantify the expected offset from growth.
- Schwab agreed to acquire USAA-IMCO assets for $1.8 billion in cash, including more than one million accounts and about $90 billion in client assets. A long-term referral agreement would make Schwab the exclusive wealth-management and brokerage provider for USAA members. Closing was expected in mid-2020, subject to approvals and conversion plans; management expected to fund the purchase from operating cash.
- Management anticipated 2019 capital expenditures of approximately 7–8% of total net revenue; spending was $544 million in the first nine months. Share repurchases totaled $2.0 billion year to date under a $4.0 billion authorization, with approximately $2.0 billion remaining at quarter-end. The quarterly common dividend had increased to $0.17 per share.
- Management described durable equity markets but noted trade concerns and a softening economic outlook. The Federal Reserve cut short-term rates by 25 basis points in July and September. Schwab’s simulation estimated that a gradual 100-basis-point rate rise would increase next-12-month net interest revenue 3.8%, while a 100-basis-point decline would reduce it 6.0%; actual results may differ and depend on balance-sheet changes and management actions.
- New banking rules issued in October 2019 place CSC in Category III and introduce tailored capital, liquidity, stress-testing, and risk-management requirements. Schwab was assessing their impact. The company also reported that the financial-statement impact of the expected LIBOR phase-out could not yet be estimated.
Risks, contingencies, and unusual items
- Results are sensitive to interest rates, client cash levels and asset flows, market conditions and trading activity, pricing competition, expense control, and the ability to attract and retain clients. Falling rates can pressure net interest revenue; commission reductions may reduce trading revenue.
- Schwab reported $5.4 billion of direct exposure to foreign non-sovereign financial and non-financial institutions and foreign government agencies, including $2.7 billion to French issuers and counterparties. It also had $667 million of margin loans to foreign residents.
- The company faces ordinary-course litigation and regulatory matters. A securities class action alleges that historical order routing violated best-execution duties; Schwab is contesting the case, and the filing says it cannot reasonably estimate potential liability at this stage.
- Schwab had $13.210 billion in commitments to extend credit or purchase first mortgages at September 30. It also disclosed guarantees to clearing organizations for which potential liability is not quantifiable, though the likelihood of payment was described as remote.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material changes to the risk factors in the 2018 Form 10-K were reported.
Important facts for investors to verify
- Track how the October commission cuts affect trading revenue, client acquisition, asset flows, and cash balances, against management’s estimated $90–100 million quarterly revenue impact at Q3 volumes.
- Assess whether lower rates and changing deposit costs alter net interest margin and revenue; compare actual performance with the disclosed rate-sensitivity simulations.
- Monitor expense growth and the effect of severance charges, technology and campus investment, and efficiency initiatives on margins.
- Check progress, final terms, regulatory approvals, funding, and conversion costs for the USAA-IMCO acquisition and referral agreement.
- Review deposit trends, liquidity coverage, capital ratios, buybacks, and dividends alongside the company’s balance-sheet and regulatory requirements.
- Follow developments in the order-routing litigation, new banking rules, and CECL adoption, including any subsequent quantified effects.